Director of Defense Procurement and Acquisition Policy Deidre Lee issued an internal memo January 31 that provides tighter criteria for waiving Cost Accounting Standards for a particular contract or subcontract. Implementing a requirement in the 2003 defense authorization act, the memo stated that DOD’s authority to waive CAS was limited to only when (1) the property or services cannot be reasonably obtained without the waiver (2) the price can be determined to be fair and reasonable without granting the waiver or (3) there are “demonstrated benefits” for the waiver. Referencing the same defense authorization act, Ms. Lee issued guidance February 11th citing the same three conditions as justifications for waiving the Truth in Negotiations Act requirements. TINA requires that contractors certify cost and pricing data they submit in support of a proposed contract over $550,000 is current, accurate and complete with rights to recover contract costs that were defectively priced. The DOD guidance also referenced recent GAO recommendations to allow TINA waivers for part of a contractor’s proposed price where it is possible to clearly identify that part of a contractor’s proposal to which the waiver may apply. Justification for such waivers will need to be documented.
The FAR Council January 30 proposed changes to the depreciation cost principle and portions of the compensation cost principle related to insurance, pensions and ESOPs.
Depreciation. FAR 31.205-11 will be changed to (1) moving the definition of “depreciation” from the cost principle to FAR 2.101, definitions (2) making the policy on residual values less restrictive and consistent with CAS 409 by allowing contractors to ignore residual value under 10 percent for computing the capitalized value of personal property to depreciate (3) removing all references to federal income tax accounting since it is unnecessary to tie allowable depreciation for government accounting purposes to that claimed for tax purposes and (4) deleting the section regarding emergency facilities.
Insurance and Pensions Costs. Makes the insurance and pension portions of the compensation cost principle at FAR 31.205-6 consistent with CAS 412, Insurance costs and CAS 413, Pension costs by (1) substituting the term “assign” for the term “account” in newly renumbered paragraphs of FAR 31.205-6 and (2) revising paragraph (j)(4)(i) to address how the government will receive the pension cost adjustment amount when there is a segment closing, a pension plan termination or curtailment of benefits.
ESOPs. FAR 31.205-6(j)(8) covering employee stock ownership plans will be revised to include (1) moving the discussion of ESOPs out of FAR 6(j), which addresses pension plans, to a new paragraph 6(q) so that ESOPs are now included in the section dealing with deferred compensation plans (2) deleting the term “individual” from the phrase “individual stock bonus plan” to preclude misinterpretation that a separate plan is required for each individual (3) adding the term “primarily” to the phrase “invest in the stock of the employer corporation” to clarify an ESOP does not have to invest 100 percent in the stock of the employer corporation (4) to make consistent with new policies and recent court decisions that ESOP costs are to be measured, assigned and allocated based on CAS 412, Pension costs for ESOPs meeting the definition of a pension plan and CAS 415, deferred compensation for all other ESOPs (5) to make consistent with IRS rules, increasing the limitation of ESOP contributions in any one year from 15 percent to 25 percent (6) removing the requirement for the CO to approve the contribution rate and (7) eliminating the discount rate provision currently in FAR 31.205-19 since CAS 416 already includes reference to the Treasury rate (Fed. Reg. January 30, 2003).
On January 27th the FAR and DFARS Council published an interim rule (effective January 24th) intended to streamline acquisition of products and services to further defend the country against terrorism or nuclear, biological, chemical or radiological attack. Certain sections of the Homeland Security Act will amend relevant parts of the FAR.
Section 853. Increases the current $100,000 simplified acquisition threshold to $200,000 ($300,000 for contracts awarded outside the US) for certain acquisition of products and services listed in Section 852.
Section 854. Increases the micro-purchase threshold of $2,500 to $7,500 for the Section 852 purchases.
Section 855. Provides for use of streamlined acquisition authorities and procedures authorized by law and waives the dollar limitation on sole source 8(a) and HUBZone awards.
Section 858. Calls for on-going market research to identify capabilities of small businesses and new entrants into federal contracting to meet agency requirements to further defense against terrorism.
The FAR Council issued a proposed rule February 4 to change various FAR costing rules. They include:
FAR 31.201-2, “Determining allowability.” Seeks to clarify that costs must meet all five requirements to be reimburseable to the government. The change provides that a cost is allowable only when it (a) is reasonable (b) is allocable to a government contract (c) meets applicable cost accounting standards and if not CAS covered, then generally accepted accounting principles (d) complies with contract terms and (e) satisfies other limitations set forth in FAR 31.2 If a contractor’s accounting practices are inconsistent with FAR 31.2 then any costs in excess of the amount that would have been incurred using the section are unallowable.
FAR 31.106-2, “Exceptions to the general rule of allowability and allocability.” The proposed change provides new details on how a contractor should make appropriate adjustments when its usual method of allocating indirect costs to a facilities contract yields “inequitable results.” The proposed rule provides that a special allocation is appropriate for (a) the purchase of completed facilities from outside sources and (b) contracts providing for installation of new facilities or the rehabilitation of existing facilities that involve the contractor’s plant maintenance workers (as opposed to direct manufacturing labor). A special allocation is not appropriate for a facilities contract that calls for construction, production or rehabilitation of equipment or other items that are involved in the regular course of the contractor’s business.
FAR 31.203, “Indirect costs.” Provides that a special allocation may be necessary in other situations where the contractor’s established accounting practices may not yield an equitable allocation to a government contract. The proposed rule outlines the methodology to use to produce an equitable result where (1) the amount of the special allocation is removed from the relevant indirect cost pool and (2) the allocation base data is removed from the base used to allocate the pool (Fed Reg. Feb 4, 2003).
Recovery of erroneous payments are becoming a “hot topic.” In response to the 2002 defense authorization act requiring federal agencies to develop a program to identify and recover overpayments erroneously made, the Office of Management and Budget has issued guidance to agencies on ways to reduce such payments to contractors (found at “www.whitehouse.gov/omb/memoranda/m03-07”). They include:
Recovery Audits. As opposed to contract audits normally conducted by government auditors, a recovery audit includes a “review and analysis of the agency’s books, supporting documents and other available information supporting its payments.” It is not intended to uncover fraud or entail examining records of a contractor. It may be performed by agency employees, other agency employees working on behalf of the agency or a contractor (typically an accounting firm) and an agency may enter into a contingency contract which allows the auditor to be paid a portion of the amount recovered.
Scope of Audits. All classes of contracts and payments may be considered for recovery audits. Agencies should identify classes of contracts having the highest potential of payment errors where the payoff is considered worth the effort and they may exclude classes of contracts deemed inappropriate or not cost effective. The following classes of contracts may (not must) be excluded: (1) cost type contracts not yet completed where payments are interim or provisional and subject to further adjustments (2) cost type contracts that were completed and subject to final contract audit (3) other contracts that provide contract financing payments where payments are interim and subject to later adjustment and (4) recent payments may be excluded for a reasonable period of time to allow normal post payment controls to find and correct overpayments.
Limitations of recovery audit contractors. The recovery audit may include a review of direct and indirect costs claimed as well as other pertinent contractor records and its established systems. There are certain limitations for recovery audit contractors where though they may communicate with contractors “shall not maintain a presence on the property of the contractor” when they are auditing. Contractors may also not (1) require a contractor to produce records or information pertaining to the audit (2) act as an agent for the government to recover agency funds (3) use or share sensitive financial information gained during an audit and (4) disclose any information of an individual for a purpose other than a recovery audit.
Following the identification of more than $200 million of overpayments it found in “special purpose audits” in 2002, the Defense Contract Audit Agency issued new audit guidance February 7 to expand its search for overpayments. It will conduct expanded audits using a new audit program at contractors where it found overpayments in 2002 as well as other contractors with “high risk billing systems.” In its 2002 audits the guidance states significant internal control weaknesses included failure to (1) periodically reconcile billed to booked amounts (2) timely resolve overpayments related to differences in liquidation on delivery invoices (3) timely processing of contract administration adjustments that impact billing (4) update alternative liquidation rates for progress billings to reflect current profit positions (5) update estimate-to-complete on contracts in a loss position and (6) lack of visibility over overpayments to subcontractors. The updated audit program reflects the lessons it learned in 2002 where the following major areas will be emphasized: (1) comparison of billed and paid amounts (2) reconciliation of recorded to billed costs (3) processing of contract administration adjustments (4) processing of demand letters (5) management of subcontractor billing (6) offsets and (7) refunds (MRD 03-PAS-014R).
The Defense Contract Audit Agency decided to respond to several concerns voiced by various industry and law organizations on its recent guidance on consultant costs. At issue is recent audit guidance issued May 9, 2002 on documentation requirements under FAR 31.205-33(f) where the guidance states that for consulting costs to be allowable, contractors must submit “supporting documentation for all three categories listed in the FAR cost principle: (1) evidence of what work was required to be performed (2) evidence supporting the invoice and (3) evidence of what work was actually performed.” The guidance says that failure to provide supporting evidence should result in not only questioning the costs but also penalties for expressly unallowable costs under FAR 42.709. The guidance also says contractors may not avoid the documentation requirements of consultant costs performed by or under an attorney on the basis of attorney-client privilege.
Industry and Bar groups have raised concerns about two portions of the audit guidance. First, they assert the reference to penalties for expressly unallowable costs is inappropriate since consultant costs are allowable. Second, they contend that the FAR cost principle cannot override legal privileges granted by the courts. For its part, DCAA aserts it must ensure its auditors have sufficient documentation to make an informed judgement on costs while the contractor groups maintain the guidance gives auditors too much leeway. DCAA says it has no intention of disallowing legitimate consulting costs but it wants to prevent services performed by attorneys or others that constitute unallowable lobbying or legal activities masquerading as consultant costs. DCAA stated it plans to “clarify” the audit guidance in its next version of the semi-annual Contract Audit Manual. In the meantime it is advising its auditors on proper implementation of the audit guidance in the form of teleconferencing rather than its usual written guidance.
The General Services Administration has issued a proposed rule to authorize state and local governments to use the Federal Supply Schedule to purchase “automated data processing equipment, software, supplies support equipment and services.” Under the proposed rule, a new contract would be formed when the schedule contractor accepts an order from a state or local entity. The state’s prompt payment laws will govern payments (if no such rule then the Federal Prompt Payment Act will apply). Dispute will be litigated by state or federal courts having jurisdiction and principles of federal law and the Uniform Commercial Code, if applicable, will rule. The Federal Government will not be liable for contractors’ performance or nonperformance. Participation will be voluntary, thus giving contractors the option of deciding to accept offers placed by state and local governments. Even after a new contract is executed contractors will still retain the right to decline orders on a case-by-case basis (Fed. Reg. 3220).
Director of Defense Procurement and Acquisition Policy Deidre Lee Jan. 28 issued a memo to heads of defense agencies that states, with few exceptions, education requirements should not be imposed on contractor personnel in solicitations for services. She stated many solicitations, which under the Federal Acquisition Streamlining Act require commercial practices and performance-based work “when feasible,” have inappropriately included education requirements for contractor personnel that mirror those for DOD’s workforce. Ms. Lee stressed that the focus “ should be on the desired outcome and provide the contractor maximum flexibility on how to deliver the desired outcome” rather than imposing education requirements. She states education requirements “should only be imposed in those rare occasions where there is a safety consideration or if educational requirements are required for professional certifications in similar jobs in private industry.”
In a separate memo to heads of defense agencies, Ms. Lee suspended for one year the price evaluation adjustment (e.g. 10%) normally given to Small Disadvantaged Businesses allowed under FAR 19.11 and the DFARS 219.11. The suspension was issued after DOD determined that in Fiscal Year 2002 it exceeded the five percent SDB contracting goal it is required to meet. Thus from February 24, 2003 through February 23, 2004, DOD contracting activities will discontinue the award of contracts to SDBs “for a price exceeding fair market cost.”
A preliminary cost analysis conducted by a subcontractor of its lower-tier subcontractor was prepared six weeks prior to the date of price certification for a prime contract covered by the Truth in Negotiations Act. When the government went after a price adjustment for defective pricing the contractor argued the cost analysis was not reasonably available to it because it had no (1) actual knowledge of the cost analysis at the time it certified its cost and pricing data (2) legal right to demand the data since at the time of its price agreement the subcontractor was not yet required to make available its cost and price data since it was not yet a subcontractor and (3) legal duty to obtain the prospective subcontractor data. The Board disagreed requiring it to pay $4.5 million for defective pricing. It stated (1) the six weeks the data was available was ample time to adjust its bid price (2) insertion of the defective pricing clause into a subcontract provides the right to demand data and (3) a prime contractor does have a legal duty to obtain cost or pricing data from prospective subcontractors. The Board stated a prime contractor’s obligation to obtain and submit accurate, complete and current cost or pricing data from its subcontractors and prospective subcontractors and update such data cannot be reduced by lack of administrative effort or lack of knowledge by the negotiators or signer of the certificate (McDonnell Aircraft Co., ASBCA No. 44504).
(Editor’s Note. Compliance with the Limitation of Funds clause is one of the most essential requirements to ensure your cost type contract remains profitable. The following demonstrates the pitfall of inadequate compliance.)
Contractor had a cost-plus-fixed fee contract to provide R&D engineering services. The contract included the LOF clause at FAR 52.232-22 which provides the government is not obliged to pay a contractor for the amount of funds in excess of those allotted to the contract, requires the contractor to provide to the CO specific written notice of potential cost overruns and entitles the contractor to stop work if the CO does not authorize payment for excess costs. Throughout contract performance the contractor provided monthly progress and funding status reports which indicated the allotted funding was exceeded. Contractor’s technical representatives did not discuss the negative balance with the CO and the contractor did not invoice the CO for excess costs. In addition, when certain participating agencies cut their funding for the contract, the contractor started a self-described “marketing campaign” to identify other agencies to continue the funding.
After the contract expired, the contractor filed a $1.4 million claim to recover the excess funds it spent. The CO denied the claim stating the contractor did not comply with the LOF clause’s notice requirements and the alleged work was not approved by the CO. In its appeal the contractor admitted it did not file the required LOF notice but argued its progress and funding reports that identified the overruns were sufficient notice and the government knew of the overruns and authorized continued performance. The Board sided with the government stating the progress reports were not substitutes for the required LOF notice because they were not addressed to the CO and did not state the additional funds needed. Citing numerous cases, the Board held that notice to technical or administrative personnel rather than the CO does not satisfy the LOF Clause. Further, mere knowledge by some government personnel that the contract is underfunded does not waive the cost limitation provisions – rather, the contractor is obligated to stop work before exceeding the funds until the CO approves the increase. In addition, because the marketing campaign to get additional funds was neither demanded nor approved by the Navy they were not owed. Finally, there was not sufficient evidence presented that showed the government induced the contractor to incur the additional costs (JJM Sys. Inc., ASBCA 51152).
(Editor’s Note. In its 1997 call to have “more open exchanges between the government and industry”, the FAR was extensively revised to address “discussions” and “clarifications.” The meaning of those terms are being increasingly defined by the following type cases.)
Three bidders submitted responses to a professional services solicitation where each offeror planned to have subcontractors perform part of the work. In response to its proposal, the Air Force asked for “clarification” on RSIS’s subcontractor’s experience and work they would perform. After RSIS received the award, ITAC protested asserting that the request for information from RSIS constituted “discussion” under the FAR. The importance of the distinction between the two types of exchanges was that under “discussions” the Air Force was required to hold discussions with all offerors so everyone could revise any weaknesses in their proposal (FAR 15.306) while “clarification” required no such exchange among the other offerors. The Court ruled the exchanges were “clarifications” because the Air Force merely requested additional past performance information but did not attempt to negotiate with RSIS or allow it to revise its proposal. It stressed the mere request for information did not constitute discussions (Information Tech. & Applications Corp., 2003 WL 102591).
(Editor’s Note. The following sadly shows that distribution of adverse audit reports requires a pretty clear demonstration of harm to prevent it. )
A contractor asserted that the release of an allegedly defaming audit report by the District of Columbia Office of Inspector would cause it to suffer “broad preclusion” from winning other government contracts and would deprive it of its Fifth Amendment due process rights. The Court disagreed. In order to prove broad preclusion the contractor had to show not only was its reputation tarnished but also “the resulting stigma altered their status in a tangible way.” The Court ruled it must be shown “the government has seriously affected, if not destroyed” its ability to obtain contracts. The facts showed the contractor was awarded a District of Columbia contract after release of the OIG report and that the District of Columbia;s decision not to renew two other contracts could not be traced to the OIG report (Trifax Corp. v. District of Columbia, D.C., Cir. No. 01-7195).
After bidders provided proposals on a “best value” solicitation, NASA allowed offerors to change their submitted labor rates to comply with a revised Department of Labor wage determination. ESU raised its base wages and stated it intended to retain 90% (raised to 100% later) of the incumbent workforce. During discussions NASA repeatedly asked ESU whether its proposed labor rates were high enough to keep the incumbent workforce by asking it to justify its proposed plan. During the last discussion ESU decided to raise its wage rates for all labor categories. Although its base wage rates were lower than Mainthia, its overhead and profit rates were higher and hence the contract was awarded to the lower priced Mainthia.
In its protest, ESU argued that NASA’s questions about its ability to meet its goals of retaining the workforce at the original proposed labor rates improperly induced it to raise those rates. As a result its proposed costs exceeded Mainthia’s costs which effectively precluded it from contract award. The Comp. Gen. disagreed noting an agency may not coerce or mislead an offeror into raising its price. It stated an agency may express reasonable concerns about an offeror’s ability to retain qualified personnel and ask them to justify or explain its proposed plan. Here, NASA informed ESU of its concerns that its labor rates were too low and merely asked ESU to substantiate its plan. It was ESU’s, not NASA’s, decision to (1) raise its retention goal to 90% then 100% (2) propose to achieve that goal by raising its labor rates and (3) and maintain higher overhead and profit rates (Engineering Servs. Unlimited, Inc. Comp. Gen. Dec. B-291275).
Price Reasonableness Applies Only to Too High, Not Too Low, Prices
(Editor’s Note. A government must make a determination of whether a proposed price is reasonable. That determination is made to find out if a price is too high. Is too low a price also unreasonable?)
The RFP for a fixed price contract included past performance and price as the only two evaluation factors and requested no technical proposals showing adequacy of staffing. When the incumbent lost the contract to a lower price bidder, it filed a protest asserting the agency did not adequately consider whether the low price offer had the staffing level required. The GAO dismissed the protest asserting “the purpose of a price reasonableness evaluation in a fixed-price contract setting is to determine whether prices are too high as opposed to too low.” Here, the contractor, not the government, bears the risk the low price will not meet the costs of performance. Since the RFP did not provide for an evaluation of staffing “it follows that alleged understaffing by the awardee, even if demonstrated to be the case, was not a basis for rejecting or downgrading the awardee’s proposal” (Sterling Services, Inc. B-291625).
(Editor’s Note. The government is requiring auditors to review contractors’ accounting systems more often, at least once a year in many cases. Auditors typically issue one of three opinions – “adequate”, “inadequate in part” or “inadequate.” The critical objective is to avoid an “inadequate” opinion since a variety of undesirable actions can occur such as failure to be awarded a contract based on cost and pricing data, suspension of payments, need to demonstrate adequacy at a later date, etc. Though less severe, an “inadequate in part” opinion can also result in adverse action, depending on what aspects of the accounting system is considered deficient.
One of our frequent consulting engagements is to conduct a “mock audit” of clients’ accounting practices where we put on our “auditing hat” and conduct a review of their accounting practices to identify weakness that can result in adverse findings during an actual audit. The advantages of contractors conducting their own audits or asking other independents to do so are many: (1) identifies weaknesses beforehand so there is ample time to take corrective action (2) supports the perception that you maintain strong internal controls since a key element of such controls includes monitoring of the system and (3) often reduces the scope of government auditors’ work, especially when you choose to provide workpapers to auditors since auditors are inclined to use the work of others (it is particularly helpful if the person conducting the audit is a CPA and has practical knowledge of government accounting requirements).
When auditors discuss adequate accounting system they usually do not mean the accounting software you choose but rather your ability to identify, segregate and report on costs of distinct final cost objectives. “Final cost objective” may mean a contract or subcontract but it may also mean contract line items or individual task or delivery orders within contracts depending on what are the specific requirements of the contract. Basically, you need to demonstrate your accounting system (no matter what type it is – packaged software, customized software, spreadsheets or manual) is an adequate project accounting system capable of identifying and reporting full costs on a project basis, particularly for government contracts.
At a minimum, contractors need to demonstrate they could pass a pre-award accounting survey that is commonly conducted by the Defense Contract Audit Agency. The criteria identified in this survey applies not only to new contractors who are likely to undergo such a survey before being awarded a contract but the same criteria is used to evaluate contractors during subsequent accounting system reviews. More detailed reviews may be required for some contractors but this survey is required of all when the government wants to be assured a contractor can account for specific project costs. The criteria includes:
1. Direct costs (touch labor, material) are properly segregated from indirect costs.
2. Direct costs are (or can be) identified and accumulated by final cost objective (e.g. grant, contract, subcontract and task or delivery order).
3. Logical and consistent method of allocating indirect costs to contracts. Allocation of costs need not necessarily be part of the financial accounting system but, for example, is accomplished on spreadsheets for those contracts needing adequate costs (e.g. cost type contracts, fixed price contracts where there are progress billings or will be used to price follow-on work, etc.).
4. Identification of contract costs in general ledger. That is, the costs that are separately identified in a cost ledger are reconcilable (i.e. visible) in accounts included in the general ledger.
5. Timekeeping system is capable of identifying employees’ labor by contract.
6. Interim (monthly) determination of contract cost through posting to books of account.
7. Exclusion of unallowable costs.
8. Identification of costs by contract line item.
9. Must demonstrate cost-type contracts can meet limitation of cost and payment clauses and fixed price contracts can meet progress billing requirements. Also, if records are sufficient to ensure reliable data is available for pricing follow-on work.
Conducting the Mock Audit
1. Request all written policies and procedures related to government accounting system. Again this does not include normal, often voluminous material on the accounting software but on aspects related to the criteria above. Demonstration that contractors have adequate internal controls are critical to demonstrating the accounting system is acceptable and written policies and procedures are often the most critical element of internal controls. The absence of at least some written policies and procedures will rarely result in an “adequate” opinion. As we discussed in the last issue of the GCA REPORT, the critical policies and procedures should address distinguishing direct versus indirect costs, screening unallowable costs, allocating indirect costs, timekeeping and expense reporting.
2. Conduct interview. The “mock auditor” should sit down with the key government accounting person(s) and conduct a detailed interview on how the system works from the time a source document is received (e.g. vendor invoice, employee timesheet) through the accounting system to job cost reports and billings to the government. Examples of relevant reports (e.g. labor distribution, other direct costs by project, etc.) should be requested and examined. The results of this should be written up, either as a narrative or as a flowchart. In addition other topics where proper written policies do not exist should be covered in the interview and notes written up covering such topics as (a) how direct versus indirect costs are distinguished (b) how indirect costs are computed and allocated to cost objectives (c) how actual indirect costs are monitored during the year and the process for changing provisional rates (d) timekeeping practices (e) expense reporting (d) practices and training on screening unallowable costs and (f) how limitation of funding requirements (e.g. notification when 75% of authorized contract value is expended) are met. Additional topics should be determined beforehand corresponding to the type of industry the contractor is in and requirements of key contracts either awarded or being bid on.
3. Trace a sample of recent invoices through the system. Select one or two invoices on high dollar cost type work or job cost records from other high dollar government work and trace reported costs back through the system.
Trace the invoice to a job cost report identifying costs. If invoice and job cost records don’t match, provide reconciliation.
Trace job cost report to intermediate reports like labor distribution, project material and other direct costs. DCAA is particularly interested in reconciling job cost labor expenses to labor distribution reports that, in turn, tie to labor hours identified in timesheets.
Reconcile direct job costs to general ledger accounts. If G/L accounts separately identify direct and indirect costs that’s great; otherwise the direct costs identified in job costs should be included in specific accounts in the general ledger.
Trace a sample of direct costs to source documents. Select a sample of high dollar direct costs. For labor, trace hours to timesheets and hourly rates to payroll records. For sample of high dollar ODCs, trace to source documents such as vendor invoices and expense reports. Reconcile any discrepancies.
Examine selected timesheets and expense reports to ensure they are consistent with written policies. If there are no written policies, ensure they are adequate according to required prescriptions set forth in the DCAA Contract Audit Manual. Though this mock audit is not intended to evaluate labor charging practices, gross inadequacies should be identified and brought to the attention of the contractor.
4. Prepare workpapers. Compile workpapers where, at least, an evaluation of each major element of an accounting survey is identified. Ensure each significant observation is identified and each conclusion is logically tied to adequate documentation. If the contractor’s system is likely to be considered adequate, either as it is now or after certain specific items are fixed, then be sure the workpapers are in logical and proper order so that an auditor may review them.
5. Write a report. Prepare a report that includes an executive summary and details of each major section. We prefer to use an observation-evaluation-recommendation format but other formats are fine. Both positive and negative evaluations should be clearly spelled out and corrective action needed to receive an “adequate” opinion highlighted.
Both the workpapers and report can be provided to a government auditor if the accounting practices are adequate or will be adequate by the time accounting practices are audited. If not adequate, you need not alert the auditor to the report. The process of preparing a “mock audit” plan and drafting a request for data, a 1-2 day site visit to the contractor, preparation of workpapers and a report usually takes about 4-6 days. We find that contractors unanimously consider the benefits of the “mock audit” to be worth the effort (and cost).
Q. Our cost type contract ends in July after which we will likely incur lower direct costs resulting in higher indirect cost rates. We use a calendar year for our fiscal period so do I need to prepare an incurred cost submittal based on January through July or for the entire year?
A. CAS 406-40(a) prescribes a full fiscal year unless certain circumstances exist (e.g. an indirect function exists for only part of the year, its established practice is to use a different period, a change in fiscal year occurs where a transition accounting period might be used). When CAS 406 was promulgated some asserted that only indirect costs incurred during contract performance be used if the period was less than one year but the CAS Board ruled against this. Even if you are not CAS covered (remember that CAS 406 applies to modified CAS covered contractors) it is instructive. In addition, FAR 31.203(e) stipulates one year – “the base period for allocating indirect costs will normally be the contractor’s fiscal year.” Keep in mind FAR 31.203 provides for a shorter period “for contracts in which performance involves a minor portion of the fiscal year” or when it is your industry’s normal practice to use a shorter period so government auditors may seek a shorter period based on these exceptions.
Q. Though I am purchasing equipment primarily for one contract, the contracting officer is adamant about not charging the equipment direct. How can I maximize recovery on the equipment without charging it direct?
A. Depending on your accounting practices, you may be able to create a separate indirect cost rate (e.g. based on location, type of contract, facilities costs) where either all or a disproportionately higher amount of the depreciation costs can be allocated to the contract. In addition, you may be able to use different assumptions about the equipment – e.g. shorter economic life, accelerated depreciation, etc. – that will not change the allocation method but will provide a faster amortization period.
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